The government’s move to withdraw higher denomination notes may also have some downsides which may ultimately impact the GDP numbers.

The positive fallout of this could be a reduction in inflation rate in the short term due to lower consumption and lesser availability of cash with people. (Illustration: C R Sasikumar)

The government’s recent move to withdraw old series Rs 500 and Rs 1,000 notes aimed at ending the ‘ghost economy’ may actually hit the real economy in the coming months. The move is expected to hamper India’s GDP growth in the short term as consumption demand, especially in rural areas, is likely to drop with reduction in cash holdings with people after the withdrawal of old series notes, which constituted about 86 per cent of the country’s total currency. The positive fallout of this could be a reduction in inflation rate in the short term due to lower consumption and lesser availability of cash with people.

Economists though have termed the withdrawal of the old series high-value currency notes as a deterrent for black money hoarders but it is being seen as a roadblock for a possible pick up in the economic growth which could have happened otherwise in the second half of the financial year with the onset of the rabi season. Apart from consumption, economists also expect production to be adversely impacted by the scrapping of old series notes especially in agricultural and SME sectors.

“As far as benefits are concerned, there is only one of imposing a fine, it’s like punishing a past crime of hoarding the cash. There is no benefit to the economy, it’s only a cost as far as economy is concerned. It negates all the benefits that were expected to flow from good monsoon, such as pick up in rural consumption. Rural economy is particularly affected. This is like having three bad monsoons,” former chief statistician and country director, International Growth Centre Pronab Sen said.

Consumption demand for consumer goods, real estate and property, gold and luxury goods and automobiles is expected to be hit in the short term. Agricultural growth, which may have boosted the total GDP growth, is now unlikely to see an improvement.

“Agriculture is going to get badly affected. Rabi planting is going to get affected. Here’s a situation where we had a good monsoon, we were looking at good crop, agriculture expanding at 3-4 percentage points — all of that will not be happening now. Not because that production will not be there but transactions will not happen. This will have knock-on effects on both formal and informal sectors. Sales of products like two wheeler, fertilisers, tractors — all are going to get affected,” Sen said.

He added that large part of credit in the economy is cash-based, especially since the banking sector does not reach out to large numbers and that ecosystem will be broken. “0.2-0.3 percentage points is the immediate negative effect on the GDP growth. So we are looking at 7.3 per cent GDP growth. But we don’t know for how long the problem will last, if the problem persists then growth will be below 7 per cent,” Sen said.

Sales and purchases in real estate sector will be amongst the worst affected by the government’s currency curb measure. Fitch Ratings said that the currency curb is likely to have a negative impact on real estate sector, at least in the next 12-24 months and is likely to be more pronounced on sales of high-end, premium property which is targeted by high-net-worth individuals and investors, rather than entry-level housing targeted by first-time homebuyers which are more often purchased by salaried individuals with limited undeclared income. “We expect homebuilders more exposed to projects in the National Capital Region (NCR) to be hit more than in other regions, because NCR is known to have a greater reliance on cash-based transactions,” the report of Fitch Ratings said.

Concerns about liquidity are also getting amplified as all of the unaccounted money is unlikely to make its way back into the banking system. This could reduce the GDP growth by 1.1 per cent in the current year, said NIPFP Professor N R Bhanumurthy.

“The withdrawal of currency notes reduce the money supply due to incomplete replacement in the system, this is expected to reduce the GDP growth in the shock year, but also in the subsequent years. However, as some of the currency, which was not part of the financial system earlier, comes back to the banking system and there are policies to increase the cashless transaction in the economy, one should expect the improvement in the money multiplier. This should have positive impact on growth and expected to result in higher growth than in the base case,” NIPFP Professor N R Bhanumurthy said.

India’s GDP growth in April-June, the first quarter of this financial year, had slowed down to 7.1 per cent from 7.5 per cent in the corresponding period a year ago. The government expects GDP growth at 8 per cent in 2016-17 on the back of improved agricultural output due to normal monsoon.

Even at the time of demonetisation in 1978, 25 per cent of the cash with public did not return to the banking system. SBI in its research report said, going by the same logic, around Rs 2.5 lakh crore will not be converted around this time and this number may even go higher .

“If we safely assume that 25 per cent of the cash with public is not converted this time also, (though this figure may be significantly higher), it turns out to be Rs 2.5 lakh crore. However, even this number may be a gross underestimation as Rs 9 lakh crore could be the possible (20 per cent of Rs 45 lakh crore black economy) unaccounted cash in the system. Thus, the actual unaccounted cash not coming back to the system could be significantly higher than Rs 2.5 lakh crore,” the SBI’s research report said.

Some economists, however, are of the view that festival demand and re-routing of currency in banking system will lessen the negative impact on GDP.

“The GDP formation could be impacted by this measure, with reduction in the consumption demand. However, the recent rise in festival demand is expected to offset this fall in overall impact. Moreover, this expected impact on GDP may not be significant as some of this demand will only be deferred and re-enter the stream once the cash situation becomes normal,” according to a report of CARE Ratings.